It is a general rule that gold operates inversely in relation to the US Dollar. If the dollar is down, gold is up as other currencies are now stronger than the dollar and can therefore acquire more gold for the same cost – therefore this increases demand for gold; and visa-versa.
This means that you can get a reading on the direction that gold is likely to move in by monitoring for big moves in the Forex markets – as Forex moves precursor those in gold.
Whilst you can trade the dollar against any other currency, it’s predominantly traded against Euros (depicted as EUR/ USD) or British Pounds (GBP/ USD). For both currency pairs the exchange rate is stated as the value of one Euro or Pound against the US Dollar – i.e. GBP/ USD 1.6000 means that for every British Pound I hold it is worth 1.6000 US Dollars.
Gold acts like a currency in its own right and, as it’s priced in dollars, it makes sense to think of its “exchange rate” being that of its current price for an ounce of gold.
All exchange rates are linked – so if the current gold price (i.e. “gold’s exchange rate”) is $1600 per ounce and the exchange rate between the GBP/ USD is 1.6000 (keeping things simple) we can deduce that if I’m holding £10,000 then I can purchase 10 ounces of gold (£10,000 x 1.6000 = $16,000/ $1,600 = 10 ounces) . If the dollar weakens against the pound to a rate of GBP/ USD 2.0000 my £10,000 would now buy me 12.5 ounces of gold (£10,000 x 2.0000 = $20,000/ $1,600 = 12.5 ounces).
Irrespective of the direction – if there is a substantial change to the value of dollar it tends to result in an inverse impact to the price of gold and, as gold reacts to the dollar price, it passes through its own technical thresholds which exacerbate or limit the impact.
The following charts from 23rd November 2012 help illustrate this. Bear in mind that the 23rd Nov was supposed to be a quiet day trading as it was the Friday after Thanksgiving in the US and so is traditionally treated almost like a public holiday and therefore trading is very light.
Like all indicators, it is not fool-proof and so shouldn’t be traded off of alone. We publish numerous articles explaining how external events impact the price of gold – the same rules apply to all and that is that these should be monitored and used to help guide your trading, but should not be the only determining factor.
You need to still be aware of the technical picture in gold itself – resistance & support levels, Fibonacci and Elliot Wave patterns, trend lines and moving averages will all play a part in exacerbating or limiting the impact of dollar-driven movements as we’ve highlighted above.
Having the EUR/ USD and GBP/ USD charts open throughout the day and monitoring for big movements should be a given. Make sure that you check them before making trading decisions – they can influence when you enter or exit, or when you move your stop loss.
When you see a strong movement in either direction which converges with a technical breakthrough on the gold chart, jump on it – more often than not it will work in your favor and usually with large gains to be made.